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23 July 2014

When QE was Privatised....



In 1916, an impoverished, partly-trained engineer called Alves Reis, son of an undertaker and with a new young wife, left his native Portugal on a ship bound for the colony of Angola. At some point, either on the voyage or shortly after arriving in Luanda, the young man forged himself a degree certificate purporting to show him as an engineering graduate of Oxford University. His career was up and running. The spell in Angola, during which time he actually became a celebrated (although still unqualified) engineer, saw him rise to be a big wheel in the colony, ultimately the owner of the Angola Railway Company; it was only blighted on his return to Portugal when, using kited cheques on a US bank, he attempted to take over a Portuguese investment vehicle called Ambaca. That effort resulted in a short gaol sentence, but was in one way the making of his subsequent career. In gaol he read a lot, including things about the Portuguese financial system, especially the intriguing fact that the Banco do Portugal, which was responsible for issuing bank notes, was at the time still privately owned. He also worked out the formula (today we’d probably call it an algorithm) they used to generate bank note numbers.

Grand Scale Forgery

Released from gaol in 1924, Reis started forgery on a grander scale. He created a purported contract from the Banco do Portugal authorising him to engage a printer to produce new bank notes.  His associates - a disparate bunch - he managed to convince that this was all part of an official secret deal to make a loan to Angola, without the public becoming aware of what their government were doing. The level of corruption within the Portuguese state at the time meant they were only too ready to believe him. Armed with the forged contract, he and his group went to the English security printing firm, Waterlows, and started ordering notes. Although he had cracked the note number code, he had no way of knowing what had already been issued, but, with another astute forgery, he convinced Waterlows, who were also the legal, official bank note printer for Portugal, that if there were any duplicates, it didn’t matter, because his new notes would be overprinted with the word “ANGOLA” when they arrived in Portugal, thus ensuring there would be no possibility of confusion. Waterlows went ahead, using the official plates for printing that they already held as part of the legitimate Portuguese business they did.

Success...and Failure

It all went swimmingly, for a bit. Reis and his associates laundered the new money - all the so-called Vasco da Gama 500-escudo notes - through a variety of channels; banks, foreign exchange companies, investment vehicles. They were rich; Reis consorted with Hollywood stars, the super-rich tycoons of the 1920s - like Ivar Kreuger, the Swedish Match king (whose own business career ended in suicide and accusations of fraud, incidentally) - and he established his own bank, Banco do Angola e Metropole. All he needed to be completely home and dry was to buy a majority shareholding in the Banco do Portugal, at which point he would have been able retrospectively to legitimise his forged contract and thus the bank notes he had produced, and he would have been the most powerful financier in the country. Alas - for him - before he had secured a voting majority of the stock, a clerk at one of the banks the group used for laundering noticed that he was seeing the same serial number on two notes (the only flaw in the scheme, since the Angola overprinting story was a sham), alerted his superior and an investigation brought the whole thing crashing down.

Reis was tried and convicted; political considerations delayed sentencing for some years, but he was eventually gaoled in 1930, being released in 1945 and dying of a heart attack in 1955. 

You can read an excellent fictionalisation of the scam in a book by Thomas Gifford, ‘The Man from Lisbon’ (currently I think out of print in paperback but available as a Kindle download); the legal case - Waterlow vs Banco do Portugal - is also worth a look in the English Law Reports. It poses an intriguing discussion about liability where forgery is involved, and is regarded as a pivotal case in English law.

Intriguing Words at Trial

So why look at an obscure 90-year old Portuguese fraud case now, apart from the fact that it’s the summer holiday season and it’s always good to have a decent financial thriller to read? Well, at his trial, Reis said something really quite interesting. He claimed that they couldn’t try him for forgery, since the bank notes he was responsible for producing were not forgeries but legitimate, and that he was doing no more than the same as the Banco do Portugal by producing currency notes for use in the economy. That was of course quite true. The notes were indeed exactly the same as those produced by the Banco do Portugal. They were printed by the same company, using the same plates, the same paper and the same ink and with serial numbers generated by the same algorithm. The authorities didn’t see it that way, but then they had good reasons not to. In fact, the Banco do Portugal was authorised to issue notes up to the value of twice its capital; by the time Reis started his operation, BdP had already issued 100 times its capital - in other words, the economy already had fifty times as much currency in circulation as was officially admitted. That’s why Reis claimed he was doing no more and no less than the BdP.

Keynesian Economics?

What he was actually doing was putting into effect Keynesian economics - boosting money supply in the expectation that that would stimulate growth. It was successful, initially. The Portuguese economy, which had been stumbling, showed unexpected growth and Portugal possibly went into the deep recession of the inter-war years a little later than similar European countries. It is unclear how much money Reis and his team put in, and the authorities never really had a hope of controlling it; the best guess, at current values, would be multiple billions of dollars, and the government reacted by withdrawing all Vasco da Gama 500-escudo notes. But who could say which ones were ‘real’ and which not? The helpful effects soon evaporated and the value of the escudo under such an influx of new money supply dropped like a stone, creating mistrust in the currency and a rampant inflation. There were significant political consequences of that crippling inflation, as well; an economist named Antonio de Oliveira Salazar was installed as Finance Minister to sort out the mess. He used that position to gain ultimate power as Prime Minister and ruled Portugal as a dictator until 1974.

Sound Familiar?

Now, does pumping newly-created money into an economy in a bid to stimulate growth ring a bell? Sounds to me rather like QE. Of course, it’s all open now, and we are told how much is being force-fed into the various economies using the measure; it’s all above board, and done by governments, so it must be all right, no? But bear in mind what Reis said at his trial, that what he was doing was just the same as what the Banco do Portugal was doing; and if you create new money that’s not got a defined value backing it, does it make a difference whether it’s state-sponsored or private initiative? The consequences - initially positive and then screamingly negative - are the same. Plenty of politicians have read history. Why do they persist in ignoring it and pretending it might all be different this time?


"The Man from Lisbon", by Thomas Gifford is available as an Amazon Kindle download. 

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